Bears Wait for the Dam To Break

Before embarking upon another assault against the liquidity forces that be,
it is worth recognizing that the remaining bears in this world have done well
despite the fact that their macro beliefs have proven untimely. To be sure,
'bears' (or value investors) that purchased select stocks during the current
bull market have produced acceptable returns, bears with precious metals exposure
since the 2003 liquidity-fest started have done exceptional, and bears that
reduced their exposure to the U.S. dollar along the way have outright thrived.
As bullish market prophets lob verbal bombs into the bears' camp claiming that
since equities have performed well the bears must be bleeding, these are important
points to remember. After all, being 'bearish' on most stocks doesn't necessarily
mean that you are heavily shorting stocks. Being bearish and being foolish
are two separate matters altogether.

Yet as prosperous as many bears have been in recent years, there is nonetheless
the uncomfortable reality that bubbly asset price movements have attacked and
undermined the bear case. Moreover, there is the possibility that the
bear case is flat out wrong, and that the financial markets have evolved and
entered a new epoch of potency. Economists have coined this 'evolutionary'
trajectory 'The Great Moderation'; which basically contends that there has
been a permanent reduction in macroeconomic volatility (Bernanke).
Most recently the Times picked
up on this theme, claiming that "Historians will marvel at the stability
of our era". Forgive us for equating these types of phrases with 'stocks
have reached a permanently high plateau', but the temptation is simply too
great.

Ironically, even some notable bears have started to tinker, albeit quite loosely,
with the idea that the global economy and financial markets are in a 'new'
paradigm. Most notably, Stephen Roach, who briefly turned bullish last year,
questioned his stripes even further in a recent
commentary:

"For longer than I care to remember, my base case has argued that ever-mounting
imbalances will ultimately crimp vigorous growth in the global economy. While
there can be no mistaking the imbalances of a US-centric world, there can
also be no mistaking the extraordinary resilience of the great global growth
machine. Is it time for a new approach?"

Have Bears Lost Their Center?

With the VIX resting near all-time lows, the S&P 500 not having corrected
by even 2% in the last 6-months, and weakness in one asset class (i.e. US housing)
simply padding expectations for spectacular gains in other asset classes, it
is difficult for pessimism to build in the marketplace. For that matter, with
some very basic valuation measures (namely trailing operating P/Es) not exactly
screaming mania, it is difficult to point to traditional overvaluation models
to extol doomsday scenarios. Suffice to say, as their forecasts prove inaccurate
bears have had to resort to less conventional platforms to build their case,
including contrarian analysis of dovish credit spreads, potential yield curve
demons, and the oft-used conclusion that there is 'excessive liquidity' in
the marketplace.

But while on the surface it would appear that bears have simply been hopping
from one sinking platform to the next, whether theorizing of an inflationary
shock, an emerging market blow-up, a collapse in housing prices, or a systemic
hedge fund default, the macro conclusion from bears is much the same: a yet
unknown catalyst is destined to arrive and expose many of the unsustainable
imbalances in the world. These 'imbalances' include, among others, the burgeoning
US trade deficit, the negative US savings rate, and the overall increased reliance
of many economies on the performance of asset prices.

Suffice to say, while 'The Great Moderation' talks about new smoothing mechanisms
at work in the financial markets and new policies/global interlinkages that
have helped steady the global economy, bears are less concerned with the last
20-years of harvests and more concerned with the seeds that have been planted.
Indeed, economic growth that is powered in large part by rising asset prices,
inflationary monetary policies, and debt creation may produce the picture of
strength, but it also causes the shadows of unsustainability to intensify rather
than vanish.

Conclusions

"If the great global growth machine doesn't start to slow by the end of
this year, it'll be high time to give up the ghost." Jan 16, 2007. Roach

With long-term bears like Richard Bernstein recently changing teams, and analysts
like Roach attaching their convictions to a timetable, it can be speculated
that we are nearing the point of universal bullishness. The bears that still
exist today should remain cognizant of this trend, and also of the fact that
as more people clamor into hedge fund hallways and volatility becomes more
widely accepted as a barbarous relic of an unsophisticated financial past,
the bear case strengthens rather than weakens.

That said, the exact point wherein the bears synchronize their macro beliefs
with the prevailing reality remains largely a mystery, and with investor risk
tolerance tests at or near all-time highs Sherlock Holmes himself is left to
scratch his head. Indeed, those who need a lesson in just how senseless things
can get should recall the late 1990s. After the Asian Crisis and LTCM blow-up
many, ourselves included, believed that an equities bust and US economic slow
down had been triggered, but in 1999 the Nasdaq gained 85%! For the record,
being bearish in 1999, even as the Nasdaq and other indices soared, proved
to be an excellent idea, although at the time the exodus from camp bear certainly
made those who remained feel a little bit lonely.

"If you need a friend, get a dog." Gordon Gekko

Being wrong about short-term movements in stock prices is not the same thing
as losing money. Those that did well in the late 1990s as well as in
2000, 2001, and 2002 (three devastating years for stocks) were those that never
bought into the idea that stocks were in a new paradigm, and those that will
likely do well in the years ahead are those that chose not to chase rising
asset prices today.

In short, with precious metals, equities, bonds, and cash (non USD) all performing
strongly in recent years, almost everyone has profited...but only one animal
is prepared for the potential damage that excessive liquidity in the marketplace
can unfurl. As bears wait for the great liquidity dam to break, the bulls pour
concrete angels around the 'Great Moderation' and hope that this time things
remain different.